NEW YORK TIMES

Oil wealth reduced, Russia needs to lure foreign capital

By David M. Herszenhorn and Andrew E. Kramer

New York Times

POSTED: 01:30 a.m. HST, Jun 21, 2013

ST. PETERSBURG, Russia » For more than a dozen years, it has been impossible to miss Russia's soaring, often ostentatious, energy wealth — the flashiness of Moscow, the 250-foot yachts and the hundred-million-dollar penthouse apartments for the children. And the riches have hardly been confined to the private sector. Last year, when Vladimir V. Putin wanted to shore up support ahead of Election Day, the salaries of government workers jumped; military pay actually doubled.

Those heady days seem to be running out, however. The great gush of oil and gas wealth that has fueled Putin's power and popularity and has raised living standards across Russia is leveling off. Foreign investors, wary of endemic corruption and an expanding government role in the economy, are hanging back, depriving the economy of essential capital.

In many respects, analysts say, the same iron fist that Putin wielded to public approval in the early years of his presidency could be the biggest obstacle to a badly needed economic restructuring, and potentially even turn public opinion against him.

Russia's economy, the world's eighth largest, slowed to a near standstill in the first months of this year, and the Kremlin is preparing to dip into its $171 billion rainy day fund in a bid to spur growth. But the problems for Russia's economy run deeper than its overwhelming dependence on oil and gas revenues, which now account for more than half the federal budget.

Despite the conspicuous consumption of oligarchs and the growing middle class in Moscow, most of Russia's goods-producing economy has been languishing for decades. Many provincial cities and towns have grown shabby, the factories that sustained them decrepit. Young people have moved away.

With flattening revenues, the government badly needs to attract foreign capital, but the Kremlin's recent move to tighten its grip on the oil industry through Rosneft, the national oil company, is just the latest warning flag to potential investors.

"The fundamental problem in this economy is still the politics of the country," said Bernard Sucher, the former head of Merrill Lynch in Russia, who serves on the board of Aton, an investment company.

"The way power is organized in this country dooms the economy to underperformance," he said. "The state is too big, it's involved in too many areas of activity, and involving itself in too many more areas of activity, and by its nature discourages private investment."

As Russia's senior political officials, business leaders and foreign investors convened in St. Petersburg on Thursday at an economic forum that serves as an annual gathering of the country's top financial minds, the task facing Putin was how to create sustainable growth in a country where commodities, taken together, now account for 80 percent of exports.

Some experts at the forum said they were confounded by Russia's contradictory problems: low growth and high inflation. "Financial policy is weird," said Yu Yongding, a senior fellow at the Institute of World Economics and Politics in Beijing. He was on a panel with Elvira Nabiullina, an aide to Putin who has been tapped to lead Russia's central bank, and Russia's economic development minister, Andrei Belousov.

Energy prices, while still relatively high, are expected to flatten or decline in the years ahead. Gazprom, the Russian energy behemoth, has been cutting prices and renegotiating contracts, under pressure from cash-poor clients in Europe and rising competition globally, caused in part by market shifts like development of U.S. shale gas.

Discounts to customers cost Gazprom $4.2 billion, or about 7 percent of pretax earnings, according to Renaissance Capital, an investment bank. Oil revenues are also projected to decline long-term as production grows more costly and new technology curbs demand.

And more than a decade of efforts to diversify the economy have largely failed. There is little to show for government-sponsored programs aimed at developing a technology sector, for instance, or reviving once-robust Soviet manufacturing.

In response to the slowdown, Putin has directed the government to prepare an aggressive and potentially risky stimulus plan that would dip into reserve funds to pay for infrastructure projects. There have been blunt warnings against tapping the reserve funds, which now total $171 billion, or roughly 8 percent of annual economic output.

"Fiscal stimulus at this time would likely be ineffective, and merely intensify inflation pressures," said Antonio Spilimbergo, who led an International Monetary Fund team that just completed a fact-finding mission in Russia.

At the same, Spilimbergo and other analysts say Russia is better positioned than many other big economies and could thrive if needed changes are put in place. "Improving Russia's business climate would provide needed impetus to investment, diversification and growth," he said.

Ksenia Yudaeva, an economist who is Putin's liaison to the Group of 20, said Russia was hardly alone in struggling to find new sources of growth. "The significant problem is uncertainty above all," she said.

"Before the crisis, it was clear that Russia has natural resources and Russia has significant demand, which was based largely on oil profits." Now, she said, investors are not sure where to look for opportunities. "It's not clear yet for investors which sectors, other than the traditional ones, will be most profitable."

Other economists said investment was the key. "If you look at growth performance, the weakest part of the economy is investment," Yaroslav Lissovolik, chief economist at Deutsche Bank, said in an interview. "To revitalize Russia's growth, measures need to be taken on the structural front, to boost investment."

Putin, who will speak at the forum Friday, is expected to try to reassure investors and to discuss the infrastructure program, as well as other strategic efforts to stimulate growth, including reducing interest rates on commercial loans.

The Russian finance minister, Anton G. Siluanov, who is leading the response to the slowdown, said in an interview that Russia was suffering partly because of continuing woes in Europe, which collectively is Russia's main trading partner, but that the government was poised to act.

"There is a question what measures have to be taken in order to stimulate the investment activity, stimulate the business activity, make the Russian economy more attractive for foreign investors," Siluanov said. "This is exactly what the Russian government is working on now."

He said the infrastructure program — high-speed railroads, major investment projects and upgrades to road networks in Moscow — would benefit the country on many levels.

Without new sources of growth, the government will struggle to meet demands for increased social spending, particularly on pensions for the country's aging population. And if the stimulus plan fails, Putin could find his political support eroding in the Russian heartland, where it remained strong even during the large street protests against him in Moscow last year.

Some of his critics are expecting, if not quite hoping for, that result. "I don't really think the economy is heading toward collapse, more likely long-term stagnation — a lost decade, if you will," said Vladimir Milov, a former deputy energy minister and now a leader in the political opposition. "This will not lead to an immediate surge in protests, but it will be very difficult for Mr. Putin to stage another successful election in 2018 should the economy be dead."

Putin envisions Russia as a global economic powerhouse, and the ruble as perhaps a reserve currency someday. But what economists almost universally cite as a precondition — a political overhaul that produces effective and reliable institutions that investors trust, and a resilient, diversified economy — so far remains out of reach.

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manakukewrote:

Dino power sources are limited; gas and oil reserves can and will disappear. The Soviet giant is gone and will not be back.

on June 21,2013 | 06:01AM

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sailfish1wrote:

I often wondered what Russia makes other than war machinery. I guess they make consumer goods but it must be sold within their country and never exported since I have yet to see a "made in Russia" item.